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					Real Estate Investments

         Topic 12
 I. The Nature & Scope of
   Real Estate Investments
A. Definition of Real Estate
    Real Estate is artificially delineated
     space referenced to a fixed point on the
     surface of the earth with a fourth
     dimension of time. It is built to house an
     economic activity that is subject to
     cultural preferences and restricted by
     the public infrastructure.
Concepts
    Space-Time Product
     • Real estate is a space-time product, that is,
       it generates income over time in exchange
       for the use of space. Examples:
       apartments, football tickets, wedding
       receptions
D. Characteristics
    The Real Estate Market Characteristics:

     •   1.   Highly Stratified, Local Markets
     •   2.   Heterogeneous Product
     •   3.   Private, not Public, Transactions
     •   4.   Unsophisticated Investors
     •   5.   Unorganized Market
E. Investor Motivations
   1. Pride in Ownership
   2. Personal Control
   3. Self-use and Occupancy
   4. Estate Building
   5. Security of Capital
   6. High Operating Yield
   7. Leverage
   8. Tax Shelter
   9. Capital Appreciation
   10. Portfolio Diversification
F. Investment Disadvantages and
Risks
  1.   Illiquid
  2.   Management
  3.   Depreciation of Value
  4.   Government Controls
  5.   Real Estate Cycles
  6.   Legal Complexity
G. Participants
  1.   Builder/developer
  2.   Syndicator
  3.   Property Manager
  4.   Construction Lender
  5.   Permanent Lender
  6.   Managing Equity Investor
  7.   Passive Equity Investor
Real Estate Investments

           Topic 12
       II. Overview of
 Investment Decision Process
A. Framework for Real Estate
Investment Studies
    1. Strategy
     • Develop an overall investment philosophy
    2. Analysis
     • Measuring return
    3. Decisions
     • Risk and return evaluations
  4. Investment Transaction
  5. Feedback
B. Investment Analysis vs.
Feasibility Analysis

    1. Investment and Investment Analysis
     •   a. Capital Assets
     •   b. Equity
     •   c. Debt
     •   d. NOI
     •   e. Lender/Equity Relation
     •   f. Maximizing Wealth
     •   g. Return and Risk
B. Investment Analysis vs.
Feasibility Analysis (continued)
   2. Feasibility and Feasibility Analysis
    • a. Site in Search of a Use
    • b. Use in Search of a Site
    • c. Investor Looking for the Best Investment
         Alternative
   3. Investment Life Cycles
    • a. Property Life Cycle
    • b. Ownership Life Cycle
    • c. Investor Life Cycle
B. Investment Analysis vs.
Feasibility Analysis (continued)

    4. Ownership Life Cycle
     • a. Acquisition
     • b. Operation
     • c. Disposal/Termination
    5. Investor Life Cycle
     •   a.   Young Investor
     •   b.   Middle Aged Investor
     •   c.   Older Investor
     •   d.   Institutional Investor
 Real Estate Investments

             Topic 12
III. Decision Making Approaches
     to Real Estate Investment
B. Traditional Financial Decision
Making Approaches
     1. Investment Value Approach
      • a. Invest if: V  C
      • b. Reject if: V  C
     2. IRV                             I
      • Assumes:
        – a. Productivity = NOI
        – b. NOI is stabilized
                                     R   o   V
        – c. Holding period is infinite
        – d. Capital is recaptured from income, except
          land
Stabilized NOI
 Ye = 10.5%
Year NOI * PV factor          PV
 1 $53,918 * .904977        $48,795
 2    56,645 * .818984       46.391
 3    59,352 * .741162       43,989
 4    62,037 * .670735       41,610
 5    64,698 * .607000       39,272
 6    67,185 * .549321       36,906
                      Sum = $256,963
Stabilized NOI (continued)
  Stabilized NOI = PV of NOI/PV of
   Annuity
  Stabilized NOI = $256,963 / 4.292179
  Stabilized NOI = $59,868
Estimating Re

 Consider:
 • a. Real Rate of Return
 • b. Inflation
 • c. Risk Premium
C. Modern Capital Budgeting
Approaches
  1.   The Present Value Model
  2.   Internal Rate of Return
  3.   Modified Internal Rate of Return
  4.   Risk Analysis
     • a. Ratio and Sensitivity
     • b. Simulation
     • c. Elasticity
Investment Principles
  1. The investor should buy the
   assumptions that create the yield rather
   than the yield itself.
  2. The investor should be as concerned
   about what to offer the next buyer as
   with what he is buying.
  3. The investor should price the
   property apart from the tax advantages.
Investment Principles
  4. The investor must compare
   alternatives.
  5. The investor should understand the
   potential profit and risk in terms of
   DOLLARS.
Sources of Return from a
Real Estate Investment
  Cash flow from operations
  Tax Savings
  Equity buildup from loan amortization
  Loan refinancing proceeds
  Appreciation of property value (sales
   proceeds)
   The Market Revenue Model :
   (Back Door)
                             Market Rents
 Equity                                              Cash
             = (1 - BEP) x                  x BEP =
 Acct.                                              Margin

- Reserves                                         - RE Taxes
- Vacancy                                          - Operating Exp.

  CTO                                             CASH FOR DEBT
                                                       
   Re                                                   Rm
  JEA                                                  JMA
                                  +
                     Justified Investment Value
  The Capital Revenue Model:
  (Front Door)

                       Cost of Project
Equity                                                  Debt
       = (1 - m) x                          x m=
Amount                                                 Amount

 x Re                                                   x Rm

 CTO                                                    ADS
                              +
                            NOI
                     + Operating Expenses
                      + Real Estate Taxes
                     + Vacancy Allowance    PGI/Net Leasable Area =
                             PGI            Required Rent to be Charged
Example Data
    1. Project Cost: $7,000,000
    2. M = .80
    3. Loan Terms: .064, 20 yrs, annual pmts.
     • Hence, Rm = .09
    4. RE Taxes = 10%
     Operating Expenses = 30%
     Vacancy Allowance = 5%
    Market Rents = $4.00/S.F.
    Reserve Account = $44,000
    Re = 14%
Example Data (continued)
  1.   Cost of Project:        $7,000,000
  2.   Loan to Value:               0.800
  3.   Mortgage Constant:           0.140
  4.   Mortgage Constant:           0.129
  5.   Operating Expenses:      $343,000
  6.   Vacancy Losses:           $55,500
  7.   Net Leasable Area: 260,000
Capital Revenue Model (CRM)
    Cost of Project:                 $7,000,000
    Equity Amount:                   $1,400,000
    Cash Throwoff:                   $ 196,000
    Debt Amount:                     $5,600,000
    Annual Debt Service:             $ 504,000
    Net Operating Income:            $ 700,000
    Plus Operating Expenses:         $ 343,000
    Plus Vacancy Losses:             $ 55,500
    Equals Potential Gross Income:   $1,098,500
    PGI/Net Leasable Area Equals
     REQUIRED RENT:                    $4.225
Example Data (continued)
  1.   Cost of Project:      $7,000,000
  2.   Loan to Value:             0.800
  3.   Equity Dividend Rate:      0.140
  4.   Mortgage Constant:         0.129
  5.   Operating Expenses:       37.21%
  6.   Vacancy Losses:            5.00%
  7.   Net Leasable Area: 80,000
Market Revenue Model (MRM)
    Market Rents:                        $1,100,000
    Cash Retained for Equity Account:    $ 166,500
    Less Reserves:                       $ 44,000
    Less Vacancy:                        $ 55,500
    Equals Cash Throw-Off:               $ 67,000
    Divided by Re Equals Just. Eq. Amt.: $ 478,571
    Account Allowing for Monies-Out:     $ 943,500
    Less Operating Expenses:             $ 333,000
    Less Real Estate Taxes:              $ 10,000
    Equals Cash for Debt:                $ 600,500
    Divided by Rm Equals Just. Debt Amt.:$6,672,222
Market Revenue Model (MRM)
(continued)
    Justified Investment Value: $7,150,793